On March 24, Zappos' 1,500 or so employees got a memo from CEO
Tony Hsieh.

"This is a long email," it began. "Please take 30 minutes to read
through the email in its entirety."

It concerned the retailer's transition to "Holacracy," a
manager-free operating structure that is composed, in theory, of
equally privileged employees working in task-specific circles,
often overlapping.

Hsieh began experimenting with Holacracy in 2013 as a way of
maintaining Zappos' lauded employee-centric culture as it
continued to grow.

The transition was supposed to have finished within a year. But
by March 2015, only 85% of Zappos employees had begun the
process.

"Having one foot in one world while having the other foot in the
other world has slowed down our transformation towards
self-management and self-organization," Hsieh wrote.

He offered an ultimatum: Embrace self-management by April 30,
or we'll give you a three-month severance package to leave.

By May, 210 Zappos employees, or 14% of the company, had taken
the offer.

What's going on inside the Amazon-owned Zappos? Hsieh is
conducting one of the biggest experiments in management history,
but one in seven employees didn't want to take part.

Hsieh has always proudly kept Zappos weird. But is he at the
forefront of a workplace revolution that could shape the future
of companies or taking the counterculture approach too far?

We spoke with Hsieh, Zappos leadership, Hsieh's self-management
advisers, and some employees to find out.

Current employees asked not to be identified by name to protect
their standing at Zappos, as did those who took the severance
package, to uphold their nondisclosure agreements.

What became clear in our reporting is the all-in approach to
Holacracy divided the company.

There are many employees who feel that Hsieh's memo was a chance
to refresh Zappos and begin a transformation into a leaner, more
innovative business. Others worry about the direction of the
company.

Can Zappos thrive without a traditional hierarchy? Or will it
self-destruct?

A visionary leader

Hsieh gives a presentation
at the 2014 CinemaCon in Las Vegas.Charley Gallay/Getty

Hsieh, who grew up in the Bay Area as the son of Taiwanese
immigrants, has always been interested in experimenting with
businesses.

As Harvard undergraduates in the early '90s, he and his friend
Alfred Lin would discuss what it would be like to run their own
companies, Lin told Business Insider.

Lin later became Zappos' first COO, CFO, and chairman, and left
in 2010 to join the prestigious Silicon Valley venture-capital
firm Sequoia Capital.

In 1997, Hsieh persuaded Lin to abandon the pursuit of a
statistics Ph.D. from Stanford and join him in San Francisco to
become the VP of finance of his first company, internet ad co-op
LinkExchange.

Hsieh and his cofounders sold LinkExchange to Microsoft a year
later for $265 million.

With money in the bank, Hsieh, Lin, and some friends from
LinkExchange moved into the same building and built Venture
Frogs, an investment fund and incubator.

In 1999, they were approached by Nick Swinmurn, founder of
shoesite.com. He wanted to create the Amazon of shoes.

Hsieh and Lin decided to invest $2 million in the site, which
Swinmurn soon renamed Zappos, a play on the Spanish word for
shoes, "zapatos."

After the dot-com crash in 2000, Venture Frogs lost all of its
investments, except Zappos, and couldn't get Sequoia to pump
money into it. Inspired by his position as the underdog, Hsieh
committed to Zappos full-time as its CEO.

"I decided that Zappos was going to be the universe that I wanted
to help envision and build," Hsieh wrote in his 2010 book
"Delivering Happiness." "I was passionate
about proving everyone wrong."

At the end of 2003, Zappos brought in $70 million in revenue and
flew employees to Las Vegas to celebrate. After the trip, Hsieh
decided that Vegas was the perfect destination to grow the
company: The city would be able to provide plenty of call-center
talent trained in Vegas' entertainment and hospitality
industries, and the lower cost of living could foster accelerated
growth.

Within a month, Zappos moved its headquarters to Las Vegas.

The lack of a startup scene in downtown Vegas, combined with the
reality that Hsieh and 70 employees had uprooted to a location
where they had no ties, presented Hsieh with the perfect
opportunity to develop a unique culture.

Zappos execs referred to
themselves as "monkeys" rather than executives. In this 2009
photo, Hsieh sits third from left, with Alfred Lin beside
him.Flickr/Robert
Scoble

If a potential employee or journalist took an office tour at the
right time of year, they would come across the "Bald
and Blue" event, a day where the Blue Man Group shaves
employees heads and legs and eyebrows, in addition to back and
chest waxing for the guys. It's become a charity event for
various cancer foundations, but began in 2005 as the bizarre idea
of an employee.

All-hands meetings are spectacles that include comedians, live
music, themed costumes, and possibly the appearance of Hsieh's
favorite animal, the llama.

According to Hsieh's philosophy, employees perform best when
they're happy, and letting them comfortably express themselves in
a fun way results in a stronger company.

It's why he's long encouraged employees to walk away if the
Zappos approach is not for them.

After a week at Zappos, an employee has three weeks to quit and
take $2,000 with additional compensation for however much time
they worked after the first week.

The buzz around Zappos' quirky employee-centric culture reached a
new high in 2009, a crucial year for the company. Zappos not only
brought in $1 billion in revenue but was also acquired by Amazon
for $1.2 billion in an all-stock deal. Hsieh had also started
planning the Downtown
Project, his ambitious plan to reimagine a sparse landscape
as a city bristling with entrepreneurial energy.

Around this time, Hsieh was studying urban development and was
especially influenced by Harvard professor Edward Glaeser's
"Triumph of the City." He was taken with the
finding that when a city doubles in population, innovation or
productivity increases per capita by 15%, which is the opposite
of what happens when a company doubles.

In the years following the Amazon deal, Hsieh searched for a way
to make Zappos more like a city than a company. Per the agreement
he made with Amazon CEO Jeff Bezos, Hsieh had the full support of
Amazon to undertake this project.

Soon he found a way to do it.

Designing Holacracy

Holacracy is the brainchild of Brian Robertson, a former software
developer and entrepreneur turned management guru.

Robertson worked his way up the ranks in the software world
during the dot-com era, and left in 2001 to start his own
company, Ternary Software.

Holacracy founder Brian
Robertson at a Zappos all-hands in 2014.YouTube/HolacracyOne

As he was growing Ternary, he said, it became clear just how
limited the management-hierarchy system was.

"It wasn't agile. It wasn't adaptable. It was crushing the
ability in people to actually contribute and use their gifts,"
Robertson said.

Forms of "self-management," where employees make most decisions
without the approval of a manager, have been practiced for
decades. But Robertson was most inspired to create his management
style by the agile software development movement of the late
'90s, which advocated a workflow that allows engineers to develop
ideas without the direction of a manager.

Robertson studied as much self-management theory as he could,
drawing lessons from a variety of techniques and philosophies.

He collected these practices together as Holacracy in 2007 and
left Ternary in 2010 to found HolacracyOne, a company that provides
tools and coaching to companies that adopt its management
principles.

The system derives its name from "holarchy," a term coined by the
writer Arthur Koestler in his 1967 philosophical psychology book,
"The Ghost in the Machine." It refers to a
collection of holons, which simultaneously function as parts and
wholes, like organs in a body.

Robertson gave a presentation on Holacracy at the 2012 Conscious
Capitalism CEO Summit in Austin. After presenting, a man
distinguished from a sea of business attire by his T-shirt and
jeans approached him and told him that he had been thinking of
ways companies could be run like cities.

Robertson impatiently answered the man's rapid-fire questions and
left as quickly as he could to get to the next presentation, not
bothering to get the man's name.

"Later in the evening," Robertson said, "he gets on stage to do
the keynote, and that's when I realized who the guy was." It was
Tony Hsieh.

Robertson, embarrassed, reconnected with Hsieh at the end of the
conference, and Hsieh invited him to meet his Zappos executive
team in Vegas. Hsieh was increasingly confident that Holacracy
held the solution to his problem.

Hsieh brought Robertson to Vegas in March 2013 to run a Holacracy
pilot program with the HR team, about 100 people.

HolacracyOne provided this graphic to show the workflow that
replaces traditional top-down management:

HolacracyOne

Rather than having static jobs, work is processed through "roles"
that are always subject to change. For example, an employee
wouldn't be a marketer but could take on the marketing role, in
addition to several other roles.

If tensions arise between employees over how work is being done,
they can raise their concerns at a regular governance meeting,
which covers big-picture ideas on accomplishing goals. Meanwhile,
tactical meetings are meant to quickly get every member of a
particular team on the same page.

Each circle is made up of smaller circles that operate on their
own but must coordinate with other circles.

While Holacracy doesn't have managers per se, there are "lead
links" who are responsible for assigning roles to their circle
and representing their circle's overall role. The difference is
that lead links are not responsible for individuals.

Technical adviser John Bunch, who is in charge of the transition
to Holacracy at Zappos, said it's important to understand that
the system functions on "distributed authority," not a total lack
of authority.

Holacracy provides a structure but leaves circle and role
creation entirely up to individual companies. This means that
corporate leadership must determine how much each role is worth
to them and how that factors into compensation. Bunch said that
Zappos is still figuring out a suitable pay model, but will not
adjust anyone's salaries during the transition process.

Distributed authority also means that actions like hiring,
firing, and the approval of expenditures cannot be determined by
an individual but are decided by a committee.

The initial transition at any company is always "painful and
uncomfortable," Robertson said, and it was no different at
Zappos. In weekly coaching sessions, there was plenty of
"resistance, frustration," and "people upset and angry" at having
to rescind the power and workflow that in some cases they had
spent long careers developing.

Generally, some managers refuse to help their former employees
after adopting the system, citing their newfound freedom, while
others flail about, frightened and confused by the idea of
self-management.

At Zappos, there was a turning point three months in, Robertson
said. Weekly meetings had become times to vent complaints and
work through challenges regarding Holacracy, but this one was
different.

"Instead of people challenging it, they were sharing what they
were learning — they were talking about how they liked it,"
Robertson said. "Multiple people came up afterwards to hug me,
some with tears in their eyes — often the same people who were
yelling at me and disliked it in the beginning."

An example of what a
company's GlassFrog layout looks like.GlassFrog.com

Not everyone was on board, Robertson said, but he had finally
converted the majority of the pilot group to his way of thinking.

It was around this point that Zappos' leadership decided they
would unroll Holacracy throughout the company, according to
former Zappos organizational design lead Alexis
Gonzales-Black. Gonzales-Black was responsible for leading
the transition alongside Bunch.

(Gonzales-Black left the company shortly before Hsieh's March
2015 memo to start a Holacracy consulting firm in San Francisco,
Thoughtful Org Partners. But she said that her departure was
unrelated to Hsieh's decision and that she remains on great terms
with Zappos.)

Robertson and HolacracyOne coaches continued to take a hands-on
approach with the pilot group for several more months. By the end
of 2013, Hsieh was confident that it was time to announce the
plan that Zappos was going to transform into a Holacracy.

At the company's fourth-quarter all-hands meeting in November
2013, HR director Hollie Delaney stood between Hsieh and Zappos
veteran executive Fred Mossler with tears in her eyes,
Aimee Groth reported for Quartz. They announced the new
direction.

Delaney cried, she said, because she had learned to let go of
power and achieve breakthroughs with her employees for the first
time.

"The auditorium filled with Zappos employees — dressed up in
animal costumes in the spirit of the meeting's theme, 'Gone Wild'
— fell silent," Groth wrote.

A month later, Zappos announced publicly that it planned on
relinquishing all manager roles and job titles by 2015.

With the transition underway, Hsieh became further inspired by
Frederic Laloux's book "Reinventing Organizations." He would later
refer to it in his memo, recommending that all Zappos employees
read it before deciding whether they wanted to remain in a
self-managed system.

Laloux is a former McKinsey junior partner and private consultant
who decided to commit full-time to spreading the gospel of
self-management in 2011. He said that he reached a point where
all he could see was how so many of the problems he addressed at
companies were due to managers who stifled progress.

He began researching development theory in tandem with
self-managed organizations around the world, such as The Morning Star
Co. in California, which has used self-management for decades
to become one of the leading tomato producers in the US.

Laloux concluded that self-management was just one element of a
new type of organization that represented the direction humanity
was heading in — away from absolute leaders and toward empowered
individuals.

Hsieh
found Frederic Laloux's book "Reinventing Organizations" so
important that he wanted every Zappos employee to read
it.Amazon

In Laloux's terms, Zappos pre-Holacracy was a Green organization
that operated with a traditional pyramid structure but focused on
culture as a means of empowering employees. Green organizations
are like families.

Teal organizations, on the other hand, are like bodies, where
every system works together to support the whole.

Both Bunch and Hsieh read the book in late 2014. Hsieh determined
that Zappos was going to become a Teal organization.

"As I read through the book," Bunch said, "it really struck me
as, 'Hey, this is saying everything that we were already saying,
and it's saying everything we want to do.'"

The main difficulty with the transition to Holacracy, Bunch said,
is that fewer than 1% of companies in the world don't have a
traditional hierarchy.

"That set of rules and those thought processes are so ingrained
in society today that it's hard to communicate exactly what the
vision is, and I think 'Reinventing Organizations' does a better
job than any other book on communicating that vision and
communicating that this is not just a hypothetical like, 'Oh,
wouldn't it be cool if we did this,'" Bunch said.

Bunch briefly met Laloux at a conference last November and put
him in touch with Hsieh.

Hsieh soon made a Skype call to Laloux, who lives in Belgium.
They chatted for a half-hour with Hsieh eagerly asking about the
mechanics of Teal organizations.

Laloux said that he finds the situation at Zappos to be
especially interesting, because while he's studied some very
successful self-managed companies around the world and across
varied industries, there's never been an attempt by a company as
large as Zappos at making a transition to becoming one.

"I expect quite a bit of confusion and chaos," Laloux said.

Struggles with self-management

Fortune's annual list of "Best Companies to Work
For" is certainly not a definitive assessment of a company's
workforce, but it's significant enough that Hsieh mentioned
Zappos' rise up its ranks in the second edition of his book.

Zappos appeared on the list in 2010 at No. 15. In 2011, it jumped
to No. 6, and in 2012 it dropped slightly to No. 11. In 2013, it
went to No. 31, in 2014 it dipped to No. 38, and by 2015 it fell
all the way down to No. 86.

Was employee enthusiasm slipping? The difficulties that come with
radically restructuring a company seemed to be taking a toll.

In the fall of 2014, the fallout of a 30-person layoff at Hsieh's
Downtown Project, which was also structured as a Holacracy, was a
blow to his public image.

A former Downtown Project employee told Business Insider that it
was easy to game the system of Holacracy, using its
project-driven circle structure to essentially create a layer of
middle management, which Holacracy is meant to replace. This
person also found the meeting system, which includes giving
everyone present a chance to speak uninterrupted in succession,
to be grueling.

Meanwhile at Zappos, an employee whose team recently adopted
Holacracy said that the lack of team managers has caused them to
drift helplessly, and that they find support with the transition
to be lacking.

Stanford Business professor Jeffrey Pfeffer said that there
are plenty of examples in the business world in which
self-management indeed leads to more efficient and productive
companies, but Hsieh's March 2015 memo is an example of how he's
going about things the wrong way.

Rather than see from the beginning if employees wanted to embrace
self-management, he declared that they had to or else leave.
"It's kind of deliciously ironic that self-management is being
decreed from above," Pfeffer said.

Robertson, the founder of Holacracy, countered, "Imagine a
country that's going to move from a dictatorship to a democracy.
The easiest possible path is for the dictator to autocratically
decree that this is now our constitution."

"It's ironic in that you now have a dictatorial decree to move to
a democracy," he said, "but it's actually the smoothest, most
powerful path to get there. And the same is true in an
organization."

Outside Zappos
headquarters in downtown Las Vegas.YouTube/Zappos

Employees divided

When the email hit inboxes on March 24, it split Zappos into
three camps: the believers, the nonbelievers, and those who
decided to remain out of convenience despite their reservations.

The believers read it as an opportunity to be at the forefront of
a workplace revolution.

For the nonbelievers, the email was a welcome opportunity to
leave an experiment they were not enjoying.

We spoke to employees who validated recurring points
in recent reviews on Glassdoor, a site where current and
former employees can anonymously rate their employers. Each
reviewer is screened to assure that they actually work or have
worked at the company they review.

The current overall Glassdoor rating for Zappos, based on 209
reviews, is 3.7 out of 5. Yet only 44% say they have a positive
outlook for the business.

One employee, who gave a two-star rating,
wrote on April 3 that their advice to management was,
"Remember that human capital is valuable rather than allowing
great talent to leave."

A former employee gave the company three stars and
wrote on April 28: "Employees are in constant fear of losing
their jobs for saying or doing something that proves to
management that they aren't a 'culture fit.'"

"With a company of our size it's easy to find people with
negative perspectives," Hsieh said. Rather than zeroing in on a
specific review, "we look at our overall data, including internal
and external surveys on employee happiness, turnover rates, et
cetera."

Another former employee told us that some employees who took the
severance package offer, even those who knew immediately they
would take it, waited to confirm their decision until April 30 to
avoid having to deal with the scrutiny of Zappos leadership.

Hsieh, however, said "the vast majority of people did not wait
until April 30."

He, along with his inner-circle members Fred Mossler, Arun Rajan,
and Hollie Delaney, held four town halls the day after employees
received the email in order to field questions. Some in
attendance expressed their anger with the suddenness of the email
and its month-long deadline, a former employee said.

"Most of the employees had not had a chance to read or watch any
of the materials that described our new direction," Hsieh said,
"so the questions lacked the proper context and background."

He also noted that it shouldn't have been a surprise. "We've been
in the process of transitioning to Holacracy for 1.5 years, so
the part about no more people managers really should not have
been news."

"Nobody was forced to take the offer," Hsieh said. "Any employee
was free to just ignore the offer, and life would have been no
different than the week before the memo came out."

Those in good standing who decided to leave were entitled to at
least three months' severance pay and to three months of COBRA
healthcare reimbursement benefits.

Both a former and current employee said that despite the offer,
some Zappos employees who had uprooted their families to Las
Vegas for the job did not feel like they had adequate time to
figure out a new plan.

One employee told us that they strongly considered taking the
offer out of unhappiness with the direction but ultimately
declined out of fear of letting go of the lifestyle they had
become used to.

And for some employees, the weirdness of Holacracy at Zappos is a
step too far, even for a company with a long tradition of
weirdness.

Employees chat inside
Zappos' Las Vegas headquarters.YouTube/Zappos

For example, although official titles were abolished, Zappos
employees could choose how to represent themselves outside of the
company. It now has roles like Time Sorcerer and Agent of WOW.
For many of those at Zappos, these names represent a self-aware
silliness that makes the workplace more fun. Others worry how
they're going to explain them on a résumé.

"The difference is that in the old world, a title implies certain
authorities," said Hsieh. "In the world of Holacracy, titles by
themselves hold no authority."

An employee who decided to stay at Zappos
wrote on Glassdoor on March 31 that Zappos is "still a great
place to work" on account of its benefits, pay, and its
employees, but that it's necessary to deal with a "disruptive
atmosphere" and "bothersome social experiments."

A former employee who doesn't like the direction of Holacracy
told us that they still think the system will end up working.
They find that most of those who remained at the company are
passionate enough to stick through challenges and young enough to
find the challenge exciting.

A former Downtown Project employee who was laid off last fall
said, from their experience with Holacracy and Hsieh, they think
he can pull it off and that Zappos will be better off for having
the 210 employees leave.

"Those were the people that didn't belong in the company anyway,"
the ex-employee said. "Not to say they're not good at their job
or that they're inferior in any way, but they don't fit in that
particular corporate culture."

Holacracy founder Robertson said he was disappointed with the way
some media outlets characterized 14% of the company leaving as a
sign of failure. He said that more people should consider that
86% of the company "turned down a lot of money to be part of the
transition to a self-organizing enterprise."

Hsieh firmly denies that his severance offer was a cost-cutting
effort. "This was a misalignment-cutting effort," he said. "We're
headed in a new direction … and want to ensure as much alignment
as possible, since not everyone is comfortable with the concepts
of self-organization and self-management that were outlined in
the memo."

The new Zappos

While it remains to be seen how this recent exodus will affect
the bottom line, Zappos announced in February that its expected
operating profits for the year are $97 million, an increase of
78% from 2014,
the Las Vegas Review-Journal reported.

They still need to determine salary processes and fine-tune tools
to assign and approve projects throughout the company. Hsieh said
they're making good progress.

And while Hsieh will still be in charge of the Zappos vision, he
will have to learn how to evolve his role.

"In the old world, many decisions would have to come to me for
final approval," Hsieh said. "Under Holacracy, authority and
decision makers are distributed throughout the company in
multiple roles and circles as we move more into self-management
and self-organization, and there are clear boundaries of what I
can and cannot make decisions about."

Robertson said that it can be useful to think of Holacracy as an
operating system. Zappos still needs to work out the bugs in its
apps. If it works, he thinks Zappos will become more agile and
thus more profitable. And if it doesn't, it will still benefit
from lessons learned.

If they stick with it, Robertson said, they're in for a
"multiyear journey" before they'll know if it truly works or not.

Bunch said that the 210 employees who took Hsieh's
severance-package offer made the right decision for both
themselves and the company.

He will be monitoring Zappos' progress in real time, he said,
rather than seeing if it meets certain benchmarks. They still
need to introduce a few hundred employees to Holacracy in their
Las Vegas headquarters and Kentucky offices.

Bunch said that he believes a fully functioning Holacracy will
make Zappos employees happier and the company more innovative,
but he's looking at it as a long-term project.

"There are going to be a lot of bumps along the way, and we're
going to have to get through it together," Bunch said.

In his memo, Hsieh wrote that after April 30, transforming Zappos
would feel like upgrading an airplane as it flies through the
air.

"Like all the bold steps we've done in the past, it feels a
little scary, but it also feels like exactly the type of thing
that only a company such as Zappos would dare to attempt at this
scale," Hsieh wrote.

"With our core values and culture as the foundation for
everything we do, I'm personally excited about all the potential
creativity and energy of our employees that are just waiting for
the right environment and structure to be unlocked and
unleashed."